Foie Gras Bubble

Nice post by Sankowski talking about the impact of negative rates and shrinking yield:

It’s worth stating clearly: negative interest rates involve paying the borrower to borrow money. In a negative interest rate environment, the lender is paying money to the borrower so they will borrow money...

It’s entirely reasonable for anyone – even a jackass like Larry Summers – to question what types of investments are so terrible someone needs to shove cash money into your hands so you will do the investment. It’s also reasonable to think forcing companies to take loans could lead to another bubble.

There is a case to be made that we should be giving private businesses and people money to promote investment. I’ve made this argument before. And, paying people to take out loans is a way to give people money, so let’s force them to take out loans, right? (Italics mine--ws)

However, if we have a choice between giving people money in the form of loans, or simply giving people cash money, I strongly prefer cash money. We do have this choice, so we should probably prefer just giving people money over incenting them to take out loans.

Not to criticize Sankowski, who I don't think believes this, but since when and how is "paying people to take out loans" a way of "giving people money"? When you take out a loan, even if it is at a very low interest rate, even if people can claim it's a negative real rate, you are not getting more money. You're getting more levered, which is the opposite of getting more money. When the problem is an overlevered economy, the solution cannot be even more leverage, but that's the only lever (apologies) the Fed really has and the confusion between this sort of horizontal money and the vertical money provided by government fiscal policy continues to lie at the heart of our ongoing financial crises and the difficulty of traditional economics to apprehend what is going on.

Another interesting consequence of QE:

First, James Monitor:

A primary channel through which this effect takes place is by narrowing the risk premiums on the assets being purchased. By purchasing a particular asset, the Fed reduces the amount of the security that the private sector holds, displacing some investors and reducing the holdings of others. In order for investors to be willing to make those adjustments, the expected return on the security has to fall. Put differently, the purchases bid up the price of the asset and hence lower its yield. These effects would be expected to spill over into other assets that are similar in nature, to the extent that investors are willing to substitute between the assets. These patterns describe what researchers often refer to as the portfolio balance channel.

Then, Sankowski:

Still, he gets close to a problem of high asset prices. His concern in the paper is about investing – it’s hard to make money in a market where the expected future returns are very low. The problem with low expected future returns is this means there is a higher possibility of losses in the asset class, and those losses are potentially larger.

Think about the household sector--if a family thinks that their 401(k) retirement plans are going to appreciate at 4% a year instead of 8% a year, does that motivate them to save more or less? Remember, the logic behind QE is that it should motivate spending, investment, and borrowing but at a household level, clearly if you expect your 401(k) to underperform, you will try and save more even though that is contrary to the policy goal.